Agricultural export earnings

The risks of dependency on commodity exports

Many developing countries depend on exports of a small number of agricultural commodities, even a single commodity, for a large share of their export revenues. This concentration leaves such countries highly vulnerable to unfavourable market or climatic conditions. A drought or a drop in prices on the international markets can quickly drain their foreign exchange reserves, stifle their ability to pay for essential imports and plunge them into debt.

As many as 43 developing countries depend on a single commodity for more than 20 percent of their total revenues from merchandise exports. Most of these countries are in sub-Saharan Africa or Latin America and the Caribbean and depend on exports of sugar, coffee, cotton lint or bananas. Most suffer from widespread poverty. More than three-quarters of these 43 countries are classified as LDCs, where per capita GDP is less than US$900 per year.

Furthermore, recent data show that few of the countries concerned are reducing their commodity dependency. In 14 of the countries, dependency on a single agricultural commodity actually increased between 1986-88 and 1997-99, and only seven countries succeeded in reducing their reliance on a single commodity. Over the past 20 years, real prices for many of the commodities these countries depend upon have fluctuated widely and fallen significantly overall (see page 11).

Declines and fluctuations in export earnings have battered income, investment and employment in these countries and left many of them deeply in debt. The International Monetary Fund (IMF) and World Bank have classified 42 countries as Heavily Indebted Poor Countries (HIPCs). Thirty-seven of these rely on primary commodities for more than half of their merchandise export earnings. More than half the world's cocoa and more than a quarter of its coffee are produced in countries classified as HIPCs.

The high cost of declining prices

Most agricultural commodities have experienced a downward trend in real prices, and the long-term forecasts are not encouraging. According to World Bank estimates for 2015, although real prices of most agricultural commodities are projected to rise above current levels, they would still remain below their mid-1990s peaks.

For some developing countries, the collapse of commodity prices was traumatic, triggering rising rural unemployment and a steep decline in export earnings. Lower income from exports has jeopardized their ability to pay for food imports, particularly in countries where food import bills account for a high share of the GDP.

If prices for the ten most important (in terms of export values) agricultural commodities exported by developing countries had risen in line with inflation since 1980, these exporters would have received around US$112 billion more in 2002 than they actually did. This is more than twice the total amount of aid distributed worldwide.

The high cost of price volatility

Although the extent of volatility has declined over the last 20 years, prices of many agricultural commodities remain highly volatile. Spikes or drops in prices can be triggered by a drought or a bumper crop. They are prolonged and deepened by the fact that both supply and demand for commodities, especially perennials, respond slowly to price changes.

When stocks are low and prices high, farmers can increase their planting, but they cannot compress the time it takes for crops to ripen to harvest. In the case of perennial crops such as coffee or cocoa, that can take years. When farmers eventually do increase production, prices fall as supplies quickly outgrow demand in importing countries, given that demand does not grow significantly in response to lower prices. The result is a pattern of short-lived booms followed by lingering slumps.

Overall, instability tends to be higher for agricultural raw materials and tropical beverages than for temperate-zone products. The former are key commodities for export earnings in developing countries.

Declining prices and price volatility cost both farmers and governments in the developing world dearly. A steep or prolonged slump in commodity prices can make debt repayment difficult, turning short-term borrowing into long-term debt. A recent IMF/World Bank publication cited a sharp drop in the prices of key export commodities as the main reason why the ratio of debt to exports had worsened dangerously in 15 heavily indebted poor countries.

Because exports provide the foreign exchange needed to repay debts, the debt-to-exports ratio is often used to gauge whether debts are sustainable. The report noted that the countries in question depended on exports of cotton, coffee, cashews, fish and copper, all of which had experienced steep price reductions.

Some countries have managed to limit, at least temporarily, the adverse effects of falling real prices on export earnings and incomes through productivity improvements and cost reduction. However, widespread adoption of cost-reducing innovations can add to the downward pressure on prices for all, while those exporters not sharing in productivity increases (often the LDCs) may find themselves squeezed between falling prices and costs that are higher than average.

Barriers to trade in developed countries - tariffs, tariff escalation and producer support

The high level of agricultural protection in both developed and developing countries and the high level of domestic support in the former have impeded growth in agricultural exports from developing countries. With the WTOAgreement on Agriculture, the Uruguay Round of trade negotiations initiated the process of reducing barriers to agricultural trade. But the level of protection remains high.

For Organisation for Economic Co-operation and Development (OECD) countries, the average bound tariff for agricultural products is 60 percent, compared with an average rate of 5 percent for industrial goods. Average applied tariffs on agricultural imports from developing countries, are estimated to be 12 percent in the United States, 20 percent in the EU, 17.5 percent in Canada and 22 percent in Japan. (Of course, these averages can only give a broad indication of relative tariff incidence, and will be influenced by the commodity and country composition of trade flows.) At the same time, preferential trade arrangements offered by some developed countries, particularly for the LDCs, have provided many opportunities for these countries to expand and diversify their exports. These have increasingly included duty-free and quota-free access to imports from LDCs as under the EU's "Everything but Arms" initiative. However, trade preferences have been underutilized in many cases. Tariffs applied by developing countries can also be high and are a constraint on the expansion of trade among them.

Tariff peaks hit hard

Average tariffs faced by developing countries may be low, but "tariff peaks" that are substantially higher than the average are applied for a number of the commodities they export, such as sugar and horticultural products. For each commodity group, the developed countries have more tariff peaks and higher average peak tariffs than the developing countries. According to the WTO, the highest tariff peaks on agricultural imports in developed countries are as high as 350 percent for tobacco, 277 percent for chocolate, 171 percent for oilseeds, and 134 percent for poultry.

According to FAO estimates, if tariffs were reduced by 40-60 percent in developed countries and 25-40 percent in developing countries, with tariff peaks being subjected to the biggest cuts, agricultural exports of LDCs could increase by as much as 18 percent.

Tariff escalation deters diversification

Exports from developing countries are also faced with tariff escalation, in which higher tariffs are levied on goods exported at more advanced stages of processing. Tariff escalation is pervasive for many agricultural commodity chains - the sequences of processing steps through which a basic commodity such as cocoa beans is transformed into a final product such as chocolate.

A recent FAO study of 16 commodity chains concluded that 12 suffer from tariff escalation, mostly at the first stage of processing. The study also found that tariff escalation is particularly pronounced in commodity sectors (such as meat, sugar, fruit, coffee, cocoa, and hides and skins) that are important to many of the poorest developing countries.

The food-processing industry includes some of the highest levels of tariff escalation and tariff peaks. Tariffs on fully processed foods in many cases are more than double the tariffs on the basic food commodities. This is seen as one reason for the limited involvement of developing countries in exporting processed products. Another recent study by FAO found that for developing countries about 57 percent of agricultural export earnings came from processed agricultural products compared with 68 percent in developed countries. For LDCs the share of processed products in agricultural exports amounted to only 20 percent. However, tariff escalation discourages investment in agricultural processing in developing countries and blunts efforts to reduce dependence on primary commodities and diversify into more highly valued products. There are, of course, other reasons, including domestic supply constraints and entry barriers arising from concentration in international markets, which discourage vertical diversification into the production of value-added forms of commodities by developing countries.

Reducing tariff escalation has been identified as one of the most important market access issues in the current WTO negotiations on agriculture. Thirteen of the 45 negotiating proposals that have been submitted called for substantial reductions in tariff escalation, particularly in the developed countries.

Subsidies
in developed countries

While tariffs have generally been falling, other policies that may further limit exports from developing countries have not been substantially modified. For example, although the value of such support has declined in both nominal and real terms, export subsidies and domestic support in some developed countries have remained high and have depressed prices on world markets, eroding the incomes and market share of producers in non-subsidizing developing countries and draining the foreign exchange reserves of many countries that depend heavily on commodity exports.

Total support to farmers in the OECD countries adds up to more than US$200 billion per year. Support has been particularly high for products such as rice, sugar, milk, wheat and meat. As the World Bank recently observed, "although official export subsidies may be small and shrinking, effective export subsidies created by domestic support are increasing". The extent to which domestic support has an impact on world market prices for agricultural commodities obviously depends on the form that support takes and the extent to which it is "decoupled".

In the case of cotton, while there are no export subsidies in the United States and the EU, various forms of direct support allow farmers to produce cotton that is then exported at prices below the costs of production. The cost of competing with exports of heavily subsidized cotton from these countries has been high for cotton farmers and cotton-exporting countries in the developing world (see box). Similarly, with subsidies to sugar beet farmers totalling more than US$2.2 billion per year, the EU has become the world's largest exporter of sugar. European sugar is exported at prices that are 75 percent below its production cost.

Constraints in developing countries

Tariffs, subsidies and other trade-distorting policies in developed countries have to a large extent eroded the market share and revenues of exports by developing countries. But policies, priorities and conditions within the developing countries themselves have also contributed to their loss of competitiveness and inability to diversify into more profitable and less volatile sectors.

During the 1980s and 1990s, many developing countries dismantled the state marketing boards that had previously exerted monopoly control over domestic trade and prices for agricultural commodities. Farmers were no longer compelled to sell at prices set far below the value of their produce on world markets. Cocoa farmers in Ghana, for example, received only 6 percent of the export price of cocoa in the early 1980s. Now they get more than 40 percent. Elimination of what amounted to confiscatory taxation on agriculture has restored incentives for farmers to increase investment and production.

In many cases, however, the abolition of marketing boards has left an institutional vacuum. Farmers often relied upon the boards for credit, fertilizer and other inputs, and for access to extension and training. Now that the boards are gone, in many cases neither government nor the private sector has taken on these roles.

Smallholders in many developing countries have been confronted by loss of access to credit and soaring prices for inputs. Poor market infrastructure and information channels leave them vulnerable to price volatility and exploitation by trading companies that have often stepped in to replace the state monopoly with a private one. At the same time, public expenditures in agriculture have dwindled. In many countries, both yields and quality of commodities have fallen since the marketing boards were abolished.

Meeting challenges and opportunities

Lack of access to credit, extension and good market information threatens farmers' ability to break their dependence on traditional primary commodities and diversify into higher-value agricultural exports. In recent years, demand for fruits, vegetables and other non-traditional agricultural exports (NTAEs) has grown, while prices for commodities traditionally exported by developing countries have stagnated or declined.

But shifting to new crops and markets requires training and investment. New entrants to the NTAE market must also meet the high quality standards and strict delivery deadlines set by the supermarkets and large retailers who dominate the market for these goods.

Small producers in developing
countries face increasing marginalization unless they adjust to these conditions.
To enter the fresh fruit and vegetable sector, for example, small farmers need
to establish marketing groups, develop communications systems and acquire the
training and tools to deliver their produce washed, trimmed, cut, graded and
labelled.

While some small producers have managed this transition effectively, the challenges are proving difficult. In general, it has been the more affluent farmers and certain more affluent developing countries that have succeeded in diversifying into NTAEs. The LDCs, on the other hand, have seen their share of both NTAEs and total agricultural exports continue to decline.

Cotton subsidies in developed countries depress world prices,
national economies and rural livelihoods

More than 10 million people in Central and West Africa depend on cotton
production for their livelihoods and food security. For many countries
in the region, cotton exports provide the main source of foreign exchange
revenues and rural employment. In 2001, cotton accounted for more than
50 percent of the total agricultural exports and 2.5-6.7 percent of
the GDP of Benin, Burkina Faso, Chad, Mali and Togo.

Working small plots of 1-2 hectares and relying on manual labour,
farmers in West Africa rank among the lowest-cost producers of cotton
in the world. Since the mid-1990s, however, they have been battered
by a collapse in cotton prices and by competition with cotton exports
from the United States. Production costs in the United States are three
times higher than those in West Africa. But United States cotton farmers
also benefit from US$3-4 billion per year in direct support - more
than the entire GDP of Burkina Faso, where 2 million people depend
on cotton production.

Between 1998 and 2001, as cotton prices slumped to record lows, cotton
production in the United States grew by more than 40 percent and the
volume of exports doubled.

The collapse of cotton prices is estimated to have cost eight West
African countries nearly US$200 million in lost annual export revenues.
The cost to millions of rural households for which cotton is the only
source of cash income has also been high. One recent study by the World
Health Organization found that West African households that grew cotton
in addition to maize had better nutrition and higher incomes. When
cotton production grew by 175 percent between 1993 and 1998, poverty
decreased by 16 percent.

Cotton subsidies in the developed countries are not the only reason
that cotton prices have fallen for domestic producers in some developing
countries. In some cases, domestic policies have also penalized cotton
producers. Moreover, technological change and competition from artificial
fibres have been pushing the world cotton price down over the past
50 years. However, a study by FAO suggests that eliminating all domestic
support - not only support notified to the WTO - would increase world
cotton prices by 5-11 percent, and would prompt an expansion in African
exports of at least 9 percent and possibly as much as 38 percent.